By Jorge Amato
Investment Strategist – Latin America
August 23, 2017
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We remain overweight many markets and assets in the region
Fundamentals in Latin America remain fairly constructive in our view. On the growth front, while real GDP for 2017 and 2018 is unlikely to be stellar, we look for the cyclical recovery to continue. Real effective exchange rates remain far from historically overvalued levels, nominal currencies should remain stable, and inflation is low. Governments continue to pursue sectoral and structural reforms, amid longstanding fiscal pressures. We believe progress will be made on this front in the coming months.
From a technical positioning perspective, we continue to see strong inflows into the asset class and the region. Citi Research estimates that emerging markets (EM) as a percentage of total investible asset classes has grown from less than 7% in 2010 to nearly 12% currently. EM has long been seen as an alternative asset class, one that cross-over investors allocated to when returns in traditional asset classes were no longer attractive. While this was positive on the upside, the opposite was true to the downside, generating unwanted portfolio flows into EM. Increased participation by long term real money investors and higher percentage participation in overall portfolios should result in more stable flows going forward.
Within EM fixed income allocations, the Citi Private Bank Global Investment Committee (GIC) continues to allocate to local debt markets, where currencies are expected to remain stable and real rates are attractive, favoring the carry trade. EM inflation has also been falling, allowing central banks to cut rates and boost total returns. While the positive feedback loop between FX/inflation/rates remains a favorable one and we do look for further interest rate cuts, we do recognize that further downside for inflation is limited going forward and real interest rates are looking less attractive at the margin.
Latin American equity markets continue to perform well. The GIC has looked beyond political noise and focused on valuations and fundamentals. Strong performance has characterized recent weeks, recovering from the second quarter’s slump. Relative valuations and cyclical recoveries suggest overweight exposure should be maintained. We recognize the potential for short-term global and region-specific catalysts to cause corrections after periods of above average returns so tactical overlays in satellite portfolios and strategies using more outright directional exposure to reduce beta make sense at current levels.